Title: Tariffs and Nontariff Barriers
1International Economics
Chapter 4
- Tariffs and Nontariff Barriers
2Chapter 4 Tariffs and Nontariff Barriers
- 4.1 Theories for Trade Protection
- 4.2 Tariffs
- 4.3 Nontariff Trade Barriers
34.1 Theories for Trade Protection
- Infant Industry Argument
- This argument contends that for free trade to be
meaningful, trading countries should temporarily
shield their newly developing industries from
foreign competition.
44.1 Theories for Trade Protection
- Some truths in the infant industry argument
- Once a protective tariff is imposed, it is very
difficult to remove, even after industrial
maturity has been achieved. - It is very difficult to determine which
industries will be capable of realizing
comparative advantage potential and thus merit
protection. - The argument generally is not valid for mature,
industrialized countries. - There may be other ways of insulating a
developing industry from cutthroat competition.
Rather than adopt a protective tariff, the
government could grant a subsidy to the industry.
54.1 Theories for Trade Protection
- Terms of Trade Argument
- In some cases, the terms of trade benefits of a
tariff outweigh its costs, so there is a
terms-of-trade argument for a tariff. - The terms of trade argument against free trade,
then, is intellectually impeccable but of
doubtful usefulness. - In practice, it is emphasized more by economists
as a theoretical proposition than it is used by
governments as a justification for trade policy.
64.1 Theories for Trade Protection
- Domestic Market Failure Argument
- Theory of the second best
- When economists apply the theory of the second
best to trade policy, they argue that
imperfections in the internal functioning of an
economy may justify interfering in its external
economic relations. - This argument accepts that international trade is
not the source of the problem but suggests
nonetheless that trade policy can provide at
least a partial solution.
74.1 Theories for Trade Protection
- Strategic Trade Policy
- Because of the small number of firms, the
assumption of perfect competition does not apply.
There are only a few firms in effective
competition in some industries. - This argument locates the market failure that
justifies government intervention in the lack of
perfect competition. - It is possible in principle for a government to
alter the rules of the game to shift these excess
returns from foreign to domestic firms.
8Chapter 4 Tariffs and Nontariff Barriers
- 4.1 Theories for Trade Protection
- 4.2 Tariffs
- 4.3 Nontariff Trade Barriers
94.2 Tariffs
- A tariff is simply a tax (duty) levied on a
product when it crosses national boundaries. - Import tariff v.s. Export tariff
- Protective tariff v.s. Revenue tariff
- Types of Tariffs
- Specific Tariff
- Ad Valorem Tariff
- Compound Tariff
104.2 Tariffs
- Effective Rate of Protection (ERP)
- the percentage change in the value added in an
industry because of the imposition of a tariff
structure by the country rather than the
existence of free trade.
114.2 Tariffs
- Calculation of ERP (Way I)
124.2 Tariffs
- Calculation of ERP (Way II)
134.2 Tariffs
- Three general rules about the relationship
between nominal rates and effective rates of
protection - If the nominal tariff rate on the final good is
higher than the weighted average nominal tariff
rate on the inputs, then the ERP will be higher
than the nominal rate on the final goods - If the nominal tariff rate on the final good is
lower than the weighted average nominal tariff
rate on the inputs, then the ERP will be lower
than the nominal rate on the final goods - If the nominal tariff rate on the final good is
equal to the weighted average nominal tariff rate
on the inputs, then the ERP will be equal to the
nominal rate on the final goods.
144.2 Tariffs
- Two consequences of the effective rate
calculation - The degree of effective protection increases as
the value added by domestic producers declines. - In the formula, the higher the value of aij
is, the greater the effective protection rate for
any given nominal tariff rate on the final
product will be. - A tariff on imports used in the production
process reduces the level of effective
protection. - In the formula, as ti rises, the numerator of
the formula decreases and hence ERP decreases.
154.2 Tariffs
- Conclusion
- when material inputs or intermediate products
enter a country at a very low duty while the
final imported commodity is protected by a high
duty, the result tends to be a high protection
rate for the domestic producers. The nominal
tariff rate on finished goods thus understates
the effective rate of protection. - But should a tariff be imposed on imported inputs
that exceeds that on the finished good, the
nominal tariff rate on the finished product would
tend to overstate its protective effect.
164.2 Tariffs
- Tariff Escalation
- The tariff structures have generally been
characterized by rising rates that give greater
protection to intermediate and finished products
than to primary commodities. - The tariff structures of the industrialized
countries may indeed discourage the growth of
processing, thus hampering diversification into
higher value-added exports for the less developed
countries, worsening the potential competitive
position of the less-developed countries in the
manufacturing and processing sectors.
174.2 Tariffs
- Tariff Welfare Effects
- Consumer Surplus
- Consumer surplus refers to the difference between
the amount that buyers would be willing and able
to pay for a good and the actual amount they do
pay. - Producer Surplus
- Producer surplus is the revenue producers receive
over and above the minimum amount required to
induce them to supply the good.
184.2 Tariffs
194.2 Tariffs
- Trade Welfare Effect of Tariff in a Partial
Equilibrium Setting - The Small-Nation Case
204.2 Tariffs
- The redistributive effect (Area a)
- the transfer of consumer surplus, in monetary
terms, to the domestic producers of the
import-competing product. - The protective effect (Area b)
- the loss to the domestic economy resulting from
wasted resources used to produce additional cloth
at increasing unit costs. - The domestic revenue effect (Area c)
- the tariff proceeds paid by country As consumers
to its government. - The consumption effect (Area d)
- arises from the decrease in consumption resulting
from the tariff's artificially increasing the
price. - The deadweight loss (Areas b d)
- represents a real cost to a community, not a
transfer to other sectors of the economy.
214.2 Tariffs
Welfare Cost of a Tariff Imposed by a Small
Nation
- Levying an import tariff, therefore, reduces a
small country's welfare.
224.2 Tariffs
- The Large-Nation Case
- The equilibrium world price is defined as the
price at which the quantity that consumers in
Country A want to import is equal to the quantity
that producers in Country B want to export. In
the diagram, this price is denoted by PFT.
International Free-Trade Equilibrium
234.2 Tariffs
- The size of the tariff equals the difference
between the price consumers in country A pay for
the product (PT) and the price producers in
country B receive (P'). That is, the per unit
tariff of t equals PT -P' .
244.2 Tariffs
- The redistributive effect (Area a)
- the transfer of consumer surplus, in monetary
terms, to the domestic producers of the
import-competing product. - The protective effect (Area b)
- the loss to the domestic economy resulting from
wasted resources used to produce additional cloth
at increasing unit costs. - The domestic revenue effect (Area c)
- the tariff proceeds paid by country As consumers
to its government. - The consumption effect (Area d)
- arises from the decrease in consumption resulting
from the tariff's artificially increasing the
price. - The terms of trade effect (Area e)
- the amount of the tariff revenue paid by
foreigners because the world price of their
exports has fallen.
254.2 Tariffs
- The change in welfare in country A brought about
by the imposition of a tariff equals e-(bd).
This amount could be positive or negative,
depending on the relative sizes of the two terms.
- Optimal tariff the tariff would be set to a
level that maximizes the area e-(bd).
264.2 Tariffs
- Trade Welfare Effect of Tariff in a General
Equilibrium Setting - The Small-Nation Case
274.2 Tariffs
- The reduction in welfare comes from two effects
- The economy no longer produces at a point that
maximizes the value of income at world prices.
The budget constraint that passes through B1 lies
inside the constraint passing through B0. - Consumers do not choose the welfare-maximizing
point on the budget constraint they do not move
up to an indifference curve that is tangent to
the economy's actual budget constraint.
284.2 Tariffs
With the imposition of a tariff, Country Is
offer curve OCI shifts inward to OCI'.
294.2 Tariffs
The Impact of a Tariff
The equilibrium quantity of exports falls from
OB1 to OB2, and the quantity of imports falls
from OA1 to OA2. Country Is terms of trade
improve from TOT1 to TOT2.
30Chapter 4 Tariffs and Nontariff Barriers
- 4.1 Theories for Trade Protection
- 4.2 Tariffs
- 4.3 Nontariff Trade Barriers
314.3 Nontariff Trade Barriers
- An Introduction to Nontariff Trade Barriers
- Import Quota
- An import quota is a physical restriction on the
quantity of goods that may be imported during a
specific period the quota generally limits
imports to a level below which imports would
occur under free-trade conditions. - A common practice to administer an import quota
is for the government to require an import
license. Each license specifies the volume of
imports allowed, and the total volume allowed
should not exceed the quota. - Import quotas on manufactured goods have been
outlawed by the World Trade Organization.
324.3 Nontariff Trade Barriers
- Tariff-Rate Quota A Two-Tier Tariff
- a tariff-rate quota displays both tariff-like
and quota-like characteristics. This device
allows a specified number of goods to be imported
at one tariff rate (the within-quota tariff
rate), whereas any imports above this level face
a higher tariff rate (the over-quota tariff
rate). - a tariff rate quota is a two-tier tariff.
334.3 Nontariff Trade Barriers
- Orderly Marketing Agreements
- An orderly marketing agreement (OMA) is a
market-sharing pact negotiated by trading
partners. - Its main purpose is to moderate the intensity of
international competition, allowing less
efficient domestic producers to participate in
markets that would otherwise have been lost to
foreign producers who sell a superior product at
a lower price. - A typical OMA consists of voluntary quotas
applied to exports. These controls are known as
voluntary export restraints (VERs) they are
sometimes supplemented by backup import controls
to ensure that the restraints are effective.
344.3 Nontariff Trade Barriers
- Domestic Content Requirements
- To limit the practice of outsourcing, organized
labor has lobbied for the use of domestic content
requirements. - The effect of content requirements is to pressure
both domestic and foreign firms who sell products
in the home country to use domestic inputs
(workers) in the production of those products. - Manufacturers generally lobby against domestic
content requirements, because they prevent
manufacturers from obtaining inputs at the lowest
cost, thus contributing to higher product prices
and loss of competitiveness.
354.3 Nontariff Trade Barriers
- Subsidies
- National governments sometimes grant subsidies
to their producers to help improve their trade
position. - Governmental subsidies assume a variety of forms,
including outright cash disbursements, tax
concessions, insurance arrangements, and loans at
below-market interest rates. - Two types of subsidies
- a domestic subsidy which is sometimes granted to
producers of import-competing goods - an export subsidy which goes to producers of the
goods that are to be sold overseas.
364.3 Nontariff Trade Barriers
- Dumping
- Dumping is recognized as a form of international
price discrimination. - It occurs when foreign buyers are charged lower
prices than domestic buyers for an identical
product, after allowing for transportation costs
and tariff duties. Selling in foreign markets at
a price below the cost of production is also
considered dumping. - Commercial dumping is generally viewed as
sporadic, predatory, or persistent in nature.
Each type is practiced under different
circumstances.
374.3 Nontariff Trade Barriers
- The effects of an Import Quota
- In the absence of trade, equilibrium would occur
at Point E with the domestic price of cloth
equaling P. - The free-trade equilibrium is located at Point F,
the domestic price of cloth would fall to the
world price PW. - The imposition of the quota changes the amount of
cloth supplied to the importing country, a new
equilibrium is reached at G.
384.3 Nontariff Trade Barriers
- The country loses Areas bcd under a quota.
- The redistributive effect (Area a)
- The protective effect (Area b)
- The domestic revenue effect (Area c)
- Area c accrues to the foreign producers and makes
them more profitable. - The consumption effect (Area d)
- The deadweight loss (Areas b d)
394.3 Nontariff Trade Barriers
- Two methods available for a government or
community to capture Area c from foreign
producers under a quota. - The domestic government could auction quotas to
importers in a free market. The limited quota
supply would go to those importers most in need
of the product who would pay the higher price. - Convert the quota into an equivalent tariff.
404.3 Nontariff Trade Barriers
- Quota and equivalent tariff
- The losses for consumers and community are much
larger in the case of a quota than in the case of
a tariff when demand increases.
414.3 Nontariff Trade Barriers
- The Effects of an Export Subsidy
- Consumers lose Area ab in the form of higher
taxes. - Producers gain Area a in profits.
- The cost to the community is Area b, that is the
production deadweight cost of the subsidy. - Subsidies are superior to protection in another
way they are more visible.